What is ARR in SaaS: Definition, Formula, Why to Track It?

SaaS businesses depend heavily on recurring revenue. Therefore, understanding all the fine nuances of various recurring revenue models is imperative if you wish to learn how to calculate it or work on it. 

Annual Recurring Revenue or ARR, is the full amount of revenue from subscriptions contracted at the end of the year. The importance of this metric grew as it became apparent that you get much more revenue from long-term customers than from one-time purchases. This also brought the SaaS industry a new department – customer success, which focuses on turning new customers into loyal ones. 

So, what is ARR in SaaS, how do you calculate and improve it, and why is it so important in SaaS? Let’s find out. 

What is ARR (Annual Recurring Revenue)?

Annual Recurring Revenue or ARR, is an important metric in SaaS businesses as it represents the total revenue a company expects to get from subscriptions, including committed revenue from signed contracts and non-committed revenue from month-to-month subscriptions on a yearly basis. It provides a predictable and steady flow of recurring revenue and serves as one of the key indicators of a company’s financial health and potential for growth. 

So, what is ARR in business and what is included in it? ARR provides a more valuable insight into a company’s recurring revenue than monthly recurring revenue or MRR, which is a measure of total recurring revenue a company expects to get on a monthly basis. ARR points out all the sources through which your company generates revenue within its initial customer base. It includes recurring payments for services on a monthly basis, recurring payments for products delivered on an annual or quarterly basis, revenue from subscriptions to online content and online communities, and similar items. 

Finally, what is ARR in sales and why is it important for the sales department? ARR in sales serves as a comprehensive measure of the value of long-term contracts or subscriptions that extend beyond the current fiscal year. Therefore, it helps sales teams forecast future revenue more accurately and assess the overall business health much easier. 

What is CARR?

Committed Annual Recurring Revenue or CARR, refers to the total annual revenue that is committed through signed contracts, while ARR includes all recurring revenue. Therefore, CARR provides a more accurate measure of future revenue, which makes it one of the most important metrics for assessing growth prospects. 

How to Improve ARR (Annual Recurring Revenue)?

ARR and customer success go hand-in-hand as recurring revenue is generated from long-term customers who achieve success with your product. Increasing revenue is the main goal of any business, so let’s see what strategies you can apply to make that happen:

• Invest in customer acquisition
  • Implement marketing and sales strategies to attract a new audience and increase your customer base. Still, make sure to find adequate ways to reduce customer acquisition costs to increase ARR and improve profitability. 
• Upsell and cross-sell
  • Expand your current customer accounts by promoting additional services or features to increase their annual revenue. Here is more information on strategies for upselling.
• Improve customer retention
  • A customer success team is responsible for ensuring excellent customer service and support, which results in an improved customer experience, higher retention rates and reduced churn rates. Customer success software like Akita can help you with customer segmentation so you can learn all about customers’ health scores, trends, patterns, and behaviors — to improve customer retention
• Raise prices
  • This is certainly a thing to consider as it can increase the average revenue per customer and ensure ARR growth. Still, make sure to add more value to the product, so that the increased prices are well justified. Also, make sure to review and optimize pricing strategies regularly to make sure they are aligned with market demands and customer needs. 
• Introducing new features
  • This is a great way to ensure additional revenue streams and upsell opportunities. Make sure to do your homework and analyze target market demands, so that you have the right audience for the new features or products. 
• Focus on retaining high-value customers 
  • Identify and retain customers who are more likely to generate bigger recurring revenue. 

How to Calculate ARR (Annual Recurring Revenue)?

To assess the health and performance of SaaS businesses and evaluate the level of ARR growth, you’ll first need to learn how to calculate ARR for a specific year. But first, let’s learn what is ARR growth. ARR growth is a metric that shows the year-over-year increase in a SaaS company’s recurring revenue from subscriptions. It is calculated by using the following formula:

ARR Growth = Current Year ARR-Previous Year ARR / Previous Year ARR x 100%

Now, to calculate ARR growth, we first must learn how to calculate ARR. So, how do you do it? First, you must calculate all the MRRs for each month and then sum them all up to get the total MRR. Then, you simply multiply it by 12 to get the ARR. Here’s the formula:

ARR = Monthly Recurring Revenue (MRR) x 12

When calculating MRR, you should include all the revenue from subscriptions and expansion revenue (upgrades), but also all the deductions related to account downgrades and cancellations of subscriptions. Remember that one-time fees like set-up fees, installation costs, and other professional service fees must be excluded as they are non-recurring.

Now, there are a few crucial components of ARR that you should analyze to understand what drives customer engagement and growth. 

1. Monthly Recurring Revenue 
   • MRR is the revenue generated from monthly subscriptions.
2. Net Annual Recurring Revenue 
   • Net ARR measures the total recurring revenue generated from subscriptions after taking cross-sells, upsells, and churned revenue into consideration. 
3. Churned ARR 
   • Churned ARR is the revenue lost from customers who cancel their subscriptions. 
4. Expansion ARR 
   • Expansion ARR is the additional revenue generated from existing customers via upgrades, upsells, or cross-sells.

Now, it might happen that the end calculation doesn’t match the annual revenue. So, why is ARR higher than revenue? Firstly, it depends on the subscription model. If the customer signs up for a high-value annual plan, the ARR for that customer will be greater than the revenue recognized in a single year. 

Also, revenue is recognized only when it is earned, while ARR considers the total value of subscriptions for their entire duration. For example, if the customer pays upfront, the revenue gets recognized in the year of payment. Finally, ARR includes churned revenue and expansion revenue, so if you have high expansion or low churn rates, ARR can be higher than your revenue. 

Importance of Tracking ARR (Annual Recurring Revenue)

Hopefully, we have given you a clear answer to the question “What is ARR in SaaS?” , but let’s see why it is so important for SaaS companies to track and monitor it regularly:

ARR allows you to plan and budget more effectively thanks to its accurate recurring revenue forecasting. Also, when you monitor ARR frequently, you can track your company’s revenue growth over time. 

Customer Lifetime Value (CLTV) is closely related to ARR as it shows the total revenue that a customer is expected to generate over their entire customer journey. When you understand ARR, you can better optimize retention and acquisition strategies.

ARR is one of the key metrics for customer success. If the rates are high, that is a clear indication that customers are deriving value from your product, which leads to subscription renewals and long-term customer relationships. 

What is ARR in SaaS? — Conclusion

ARR is definitely one of the most crucial metrics in SaaS, as it represents the total annual revenue you expect to get from subscriptions.

 It provides valuable insights into growth potential, revenue dynamics, financial forecasting, and customer success. By understanding it and managing it properly, you can improve customer retention, drive business growth, and build a strong foundation for sustained success in the ever-growing SaaS environment.